Thursday, November 10, 2005

Pricing Oil

It is lots of fun to blame the oil companies for whatever is wrong with our society. The CEOs of these companies usually remain silent and just keep plugging away at keeping us supplied. We really need oil--some have correctly noted that oil runs the engine of Democracy.

What really bothers many people is that gasoline costs more than it used to cost. I can recall gas at twenty-five cents a gallon. Now it costs ten times that amount. So does everything else, but their are few complaints about those other things--just gasoline.

There are cries that oil companies are making too much money. This should please many on the Left, because they consider oil to be bad and know that as prices rise usage will fall. Yet they complain loudly instead of congratulating each other. It is hard to figure.

As a student of economics at the graduate and undergraduate level, I have wondered at the charge of price gouging by the oil companies. It seems that the laws of supply and demand are all right for salt but not for oil. On the one hand people on the left are saying that people have cut back. On the other hand they say that there is a large demand that has not changed. They can't have it both ways. Either demand has fallen or it has not. Since "they" are not economists but media types, "they" have special expertise that is not hampered by serious study. Only movie and TV actors know more than media types.

There is a world-wide demand for oil that has increased steadily over the years. The supply has not quite kept up with the demand so prices have risen.

Some argue that oil companies are making too much money and should be subject to an excess profits tax. That raises a group of related questions. Here are a few:

1) How much profit is too much?

2) Who will decide how much profit is acceptable?

3) When oil companies lose money, will the government give them money to make up for an "excess losses"?

4) Will other companies (such as Microsoft) be subject to an excess profits tax? Government should be universal, not picking on only one industry or individual.

5) Does the government really want to set prices and limit profits? So far as we know the planned economy has never been successful.

What about prices? Should a corporation give back part of its profits by reducing prices? How much should they give back, and to whom? Oil and all other companies are prohibited by law from getting together and setting prices. It was an oil company that caused the law to be enacted in the first place, over a hundred years ago.

Suppose executives in the Essoil Oil Company decided that making nine to eleven cents on every sales dollar was too much. So they decided to cut back and reduce prices by five per cent. What would happen? Would other oil companies follow suit? Demand is too high for that. All Essoil gasoline and oil products would be gobbled up and they would find their supplies gone. The other oil companies would continue to sell their products at their old prices. The president of Essoil would be tossed out because he did not look out for the stock holder.

Suppose times were different. Suppose there were more gasoline and oil products available than people could easily use. Then if Essoil reduced its prices, the other oil products companies would follow and reduce prices in order to keep their market share. They might even find that at lower prices people would drive more and use more plastics and other petroleum-based products and their total revenues might even increase. Profitabilty might increase because they have huge fixed costs. Those fixed costs spread over greater volume might mean that even at a reduced prices, profits increase.

It is a complex problem that each company has to solve for itself.

One thing that can happen immediately to reduce prices is Government taking less of a tax bite. Senators and congressmen will never suggest such a thing. But Government can meddle or threaten to meddle and bring about all kinds of unintended consequences. Government rumbling and jawboning may achieve votes for those about to enter a new election campaign, but it is certain to create uncertainty in business, which always increases risk and keeps prices up (except in the stock market, where prices often plunge).

Let the market decide if prices are too high. It is a marvelous mechanism for allocating scarce resources.

About Me

Thomas Fiske is a former executive of manufacturing companies who retired to do those things he liked best—to write and snooze. When he found he was a failure at one of these tasks he filled in part of his time by substitute teaching at a nearby middle school. He is a graduate of Case in Cleveland with an MBA. These days he is a second class, second tenor in a local choir in Fullerton, California. Late in his life Tom has returned to his Ham radio interests and has become AA6TF.